Thought of The Day — The Fiscal Cliff: A Compromise?

The President will meet this morning with Congressional leaders to discuss the nation’s head-long dash toward a date that will cause tax rates to rise and sequestration for government programs, primarily Defense. In preparation, on Tuesday the President met with union leaders and heads of other “progressive” groups, and on Wednesday he met with business leaders. We know who will show up from Congress this morning. The question is which Mr. Obama will appear, the conciliator or the ideologue?

As he starts out on his second term, Mr. Obama has sent mixed messages. When with union leaders, he appears intractable, in terms of his stance on the “wealthy” having to pay higher rates. When he is with business leaders, he sounds more conciliatory.

The President does not appear to be in a conciliatory mood. Wednesday, at his bi-annual news conference, he remarked that John McCain and Lindsay Graham were out of line regarding their comments as to the suitability of UN Ambassador Susan Rice to be Secretary of State; he had the gall to blame Republicans for picking on her for going on five Sunday TV talk shows five days after the attack on the Consulate in Benghazi during which she relayed the Administration’s lie as to what caused the attack in Benghazi on September 11th. Within twenty-four hours of the attack, if not sooner, the Administration had been told the attack was pre-planned by al Qaeda and their affiliates. The Administration knew the cause was not a video, yet they persisted in claiming it was. It was Mr. Obama who threw Ms. Rice under the bus by having her mislead the American people, not Mr. McCain or Mr. Graham. He also threw Secretary of State Hillary Clinton and DCI David Petraeus under the same Chicago bus for telling the same tale. This is not a man with whom negotiations will be easy. He wants his way, and his conceit says he deserves it.

However much the President likes to think of himself as the voice of the nation, he is the president of a republic, not an irreproachable monarch. He won re-election, but he gathered only 50% of the vote, less than he did in 2008. He must know that the opposition is not defunct. Republicans control 30 of the 50 governorships, including seven of the ten most populous states. They control 27 state legislatures and 28 state senates. In a USA Today poll out yesterday, optimism in the country has fallen.

As everyone knows, the sticking point is the President’s demand that the tax rate on those making more than $250,000 ($200,000 for singles) must go up. The Republican’s response is that those income levels include a large number of small businesses that file as individuals, which will likely cause lay-offs. One alternative is the one proposed by the Simpson-Bowles Commission (and by Governor Romney) of limiting total deductions – charitable, mortgages, state and local taxes – for high earners to some fixed amount; for example $30,000. There are those like Robert Rubin who oppose such recommendations, which is unsurprising. Such a decision would make it harder for him, and people like him, to hide income. He prefers higher tax-rates, because they don’t interfere in his ability to continue to avoid taxes. A higher tax bracket is Mr. Rubin’s briar patch, as it is for Warren Buffett and others like them.

The President has raised the ante. In the summer of 2011, in a grand bargain, he and Mr. Boehner agreed on revenue increases of $800 billion over ten years. After a deal had been struck and agreed upon, Mr. Obama changed his mind and asked for $1.2 trillion. Mr. Boehner refused. At that point, the concept of the “fiscal cliff” was introduced, as a means of forcing action. Now the President has asked for $1.6 trillion in additional tax revenue over the next decade. In Wednesday’s TOTD, I showed how $2.0 trillion over ten years could be achieved by limiting deductions, but it appears the President is determined to make a political point of raising taxes on the “wealthy” regardless of the consequence and no matter how little will actually be collected. It is a case of ideology superseding common sense.

The fiscal cliff, according to conventional wisdom, poses little risk for the President. He is in his last term. He has, as he whispered to then Russian President Dmitri Medvedev last March, “more flexibility” now that the election is over. Should we slip over the edge and into the abyss, the effect would likely be a recession. Everybody’s taxes would rise, which could be blamed on Congressional Republicans. Defense spending would be cut, which would be okay with Mr. Obama. Entitlements would not be touched, so the spending spree would continue. With Republican’s suited out in a dunce cap, Mr. Obama would practice what he does best – passing the blame. But that may not be the consequence. The President, after all, is the man in charge.

The silly posturing going on by both sides understates the seriousness of the problem and defers an even more serious question that needs to be asked. The problems are ones of debt and deficits. The inflation adjusted fiscal deficit in 2008 was $488 billion. Last year, it was $1.32 trillion. It has been in excess of a trillion dollars since 2009. In 2012, it is expected to be reported at $1.1 trillion, moving in the right direction, but still way too excessive. Another recession would cause revenues to decline further and the deficit to widen. In 2008, total federal debt -excluding obligations to Social Security, Medicare, Medicaid and now Obamacare – was $10 trillion. Today it is $16.3 trillion. That means $50,000 worth of debt for every man, woman and child, an amount equal to the annual income for the average American worker. When future entitlement obligations are factored in, debt numbers roughly quadruple. Welcome to America!

Anyone who doesn’t think we have a problem is living on another planet. One who doesn’t think we have a debt crisis is the President’s buddy, AFL-CIO President Richard Trumka. He and his pal, Mary Kay Henry, President of Services Employees International Union, held 100 rallies last week pressuring Congress on holding off on any entitlement cuts. They walked out of last Tuesday’s meeting with the President feeling the “rich” would pay more and being assured that entitlements would not be touched. Thus they told the President that they “had his back.” These are the fiscally irresponsible leaders who have helped bankrupt businesses, states and cities. They are now vowing to do the same to the federal government. Left untethered, they will.

The more serious question that needs to be asked is what kind of government do we want. Following Lyndon Johnson’s great society, federal spending, as a percent of GDP, began rising toward the 20% level. In the 1950s and early 1960s, it had been closer to 15%. It remained at the 20% level through George W. Bush’s second term. President Obama has taken that number up closer to 25%. If that is what the American people want, it means that taxes on everyone will have to go up, not just the wealthy. The President has persistently vilified the wealthy, claiming they don’t pay their fair share. The fact is that, in 2011, the top 10% of America’s workers earned 48% of the nation’s personal income and paid 70% of all federal taxes, the highest percentage ever. If the people of America want a paternalistic welfare state, such as the one depicted in “Julia’s World”, which can be seen on the White House’s website, everybody’s taxes will have to go up substantially, first to pay for the new programs and second to offset the decline in GDP growth that would inevitably ensue.

I don’t get the sense that the Administration (or Congress) is fully aware of the explosive nature of the powder keg with which they are dealing. The best way to resolve the problem is through economic growth, which would lift tax revenues while reducing unemployment and poverty. That is indeed possible, but it means unleashing the animal spirits of the private sector – limiting regulation and reducing taxes, exactly the opposite of what this President wants to do. The fiscal cliff should be avoided if possible, but if the consequence of avoidance is simply to push out the tough decisions that must be made, then facing reality today may be better than confronting a bigger problem tomorrow.

If we were to nosedive off the cliff, markets would weaken sharply, as would the dollar. International disillusionment with the United States could cause interest rates to rise. But it is possible that such a crisis might be a wake-up call to finally address the fiscal issues that have been avoided by Republicans and made worse by Democrats for too long. If markets sensed that we were serious about addressing the problem, they would recover; so any shortfall might prove temporary. If, on the other hand, they saw the leap off the cliff as a means for the President to pressure Congress to come around to his plan of continuing the process of wealth transfer, high unemployment and slow economic growth, then, as Betty Davis once said, we had better “buckle our seat belts; it’s going to be a bumpy ride.”